LBW INSIGHTS

​​There are books full of different ways to categorize, screen, and evaluate a good investment, but instead of theories they are called strategies. For example, LBW would be considered a “value” investor because we implement a “value” investing strategy[1]. There are many other strategies such as growth, passive, strategic allocation, dynamic allocation, market neutral, etc. – you get our point. One strategy that has become a hot topic in recent years is Sustainable, Responsible, and Impact investing (SRI). For this month’s blog, we would like to take a dive into what SRI is, how it is categorized, and our general thoughts on this type of strategy.

At the end of the first quarter (“Q1”) of every year, it begins to feel like spring (well sometimes not in WI), bringing great memories. One of my (Tim’s) favorites: the anticipation of knowing that the Salt Lake City Firefighters’ annual Lagoon day was around the corner. It was almost time to go ride the best roller coaster in UT, the Colossus[1]. I would constantly think about getting in the cart and going up the first hill, hearing click, click, click, until finally it was no more. And then boom – flying down the hill, zipping around corners, going around, not just one, but two full loops! It was a kid’s dream. Now, I may not be able to go ride the Colossus this year, but the markets in Q1 stepped in and took its place. For example, from the beginning of Q1 to its peak, the S&P 500 gained roughly 7.45%[2] (the hill). And from its peak to trough[3], it dropped -10.16%[4] (the drop), which, by definition, is a correction[5]. By the end of the quarter, the S&P 500 gained back roughly 8.93%[6] (the loops) of what it had lost and ended the quarter down -1.22%[7] (the finish).

In our blog, “Making the Bet - Part 1: The Game”, we made the point that concentration is often viewed in a vacuum and instead needs to be viewed holistically. Doing so can uncover concentration and previously-unknown risks. However, concentration from a finite level – such as a portfolio level – is just as concerning. If possible, one must be aware of their concentration on a macro level (“The Game”) and a micro level (“The Hand”).

​The word concentration is frequently used in the financial world. Phrases like “you need to be more diversified to avoid concentration” or “you are over-concentrated in equities” are often thrown around by financial professionals, and for good reason, as concentration is a real risk. The issue, however, is these phrases likely pertain to concentration in an asset class, individual company, or some other related stock market investment. Such assessments are made with isolated information, instead of being examined from a holistic view point.

​Introduction This month’s blog is going to be slightly different than usual; rather than having Tim, Nathaniel or Dan discuss a financial topic, I’ll be writing about my perspective of the financial services industry. But before we get into that, a brief introduction is in order.

At some point in life you’ve probably thought, “I wish I could get paid without having to go to work.” Luckily for you, that’s exactly what an IRA is for: saving enough money now so that you can pay yourself not to work (commonly known as retirement). To understand how this is done, let’s start with the basics:

The first day of my (Tim) Introductory Microeconomics class our teacher provided us with a few key tenants surrounding microeconomics; 1) assumptions must and will be made (I still don’t agree with this principle and feel it can distort the real world – maybe it will be our next blog post), and 2) there is no such thing as a free lunch. The second point baffled me at first. I had heard of opportunity cost, but I had never truly sat down and thought of its real-life application. Our teacher began peppering us, attempting to see if we could break this fundamental rule. It is a difficult and an almost impossible task. Anything you do has another side of the story; as humans, we are constantly battling a zero-sum game[1]. Opportunity cost is real and is a core tenant not only in economics, but in your financial plan as well.

​When a family or individual approaches us to begin assessing their ability to retire and live on a fixed income, we explain that financial planning comes down to a simple equation: income (I) – expenses (e) = free cash flow (FCF). Where things become subjective and more complicated is the composition of I and more specifically E. A subjective piece to E, is the rate at which it is increasing over time, otherwise known as inflation. One metric used to describe inflation is the Consumer Price Index (CPI)[1], which measures the rate of change for a basket of goods and services purchased by households. CPI is a general indicator of the rate at which E is increasing over time. The issue – not every E category is inflating at the same rate. Furthermore, each E category has a differently weighted percentage relative to E. Meaning, averaging CPI over time and applying that percentage across all E categories may produce results that are not indicative of the future. To produce a more accurate picture, you must understand the amount you will be spending for each E category and then apply an appropriate inflation rate[2]. Moving forward, one E category one must truly understand is healthcare.

How LBW Sees It

At LBW we typically take a contrarian view as it pertains to our industry – it’s built into our culture. However, performance chasing[1], and the potential harm it can cause, is a subject where sticking with the crowd seems best. Instead of going into a boring definition, here is a quick exercise. Please read the following passage:

Often, we are asked “How are the markets doing?” – well, they aren’t doing too shabby this year. Year-to-date (“YTD”) the S&P 500 is up 12.53%[2], the Russel 3000, up 13.91%[3], and the MSCI World ex USA, up 19.31%[4].

What were your thoughts? Did you immediately think “Did I have exposure to the MSCI World ex USA index? If not, is there a way to participate?” At the very least, the almost 20% YTD return from the MSCI World ex USA index must have caught your eye. The subconscious gravitation towards the highest return number is the starting point of performance chasing and can cause people to chase one excellent return after another. It has been highly researched and the negative effects are cause for concern. For example, Morningstar[5], a well-known investment research and analytics company, ranks funds by stars – five indicating the best and one indicating the worst. Plenty of research has been done arguing the validity of the rankings and the strategy of buying five-star funds versus other-star funds. Most of the findings come to the same conclusion – past returns are not an indication of future results. Simply put, the rankings are a better marketing tool than a fund selection tool.